An 8.5% Yield at a Fire-Sale Price

It's not every day a quality dividend stock yielding almost 9% goes on sale at almost 20% off.

But that's the deal that readers of High-Yield International were alerted to three weeks ago. And it's not too late for the rest of us to do some bargain hunting of our own.

Here's the scoop...
Student Transportation (Nasdaq: STB; TSX: STB) operates in a unique niche. The company provides bus transportation for school districts. And for roughly the past two years, its stock has been a bellwether holding within Paul Tracy's High-Yield International model portfolio.

In fact, during the prior 15 months the stock delivered total returns, including dividends, of 64.2% -- more than triple the total returns of the S&P 500 during the same period. Moreover, right now the stock pays an 8.5% yield based on monthly dividends of nearly a nickel per share.

Then last on Thursday, July 26, the share price began to sink.

And then it sank some more.

By the first hour of trading on Monday, August 30, the company's shares had shed 17.6% of their value -- in less than a week.

Any number of factors can weigh on the price of a company's stock, including a disappointing earnings report, an analyst downgrade, general market malaise, a cut in the dividend or a sudden change in the business outlook.

In the case of Student Transportation, a Canadian company with corporate offices in the United States, none of these applied.

So what gives?

It turns out investors were spooked by a report from a hedge fund manager that quickly made the rounds on the Internet. There's no doubt the research looks impressive.

But Paul's research staff culled through the report... a report that Paul labeled "flawed" and "suspect" in a special e-mail alert to High-Yield International readers.

"Suspect" because the report's author -- Prescience Investment Group, a small hedge fund in Baton Rouge, Louisiana -- by its own disclosure held short positions in STB's stock at the time they released the report. In other words, the hedge fund likely profited from the very share-price drop it triggered.

Paul put it best...

"Prescience's lack of independence and the convenience of Student Transportation as a target for its negative report do not necessarily mean the contents of the report are incorrect or that the opinion is wrong. But they do call into question the motives Prescience had in releasing its report free of charge on the Internet and via posts on popular financial websites. The hedge fund certainly has a financial incentive to paint Student Transportation's fundamentals in a negative light as a drop in the share price would result in profits for Prescience."

But as I said, Paul found the analysis "flawed" as well. That's because many of the report's assertions, most of which revolve around allegations the company doesn't have the cash flow to cover its dividend, are highly dubious, according to Paul.

One example: The report cites STB's reported earnings per share as "proof" that the company can't pay its dividend without "continually raising fresh capital from new investors in order to pay its fixed dividend to existing investors, or 'taking money from Peter to pay Paul.'"

On the surface this might appear to be true. In fiscal 2011 Student Transportation earned $0.03 per share -- clearly not enough to cover its roughly $0.56 annualized dividend.

However, "Earnings and earnings per share are accounting measures that include a number of non-cash charges," Paul pointed out in his report. "As such, they aren't relevant metrics in this case."

"In the case of Student Transportation's fiscal 2011 results, the company reported net income used to calculate EPS of just $1.59 million, but that includes total depreciation charges of nearly $33.2 million. For some groups of companies, such as master limited partnerships (MLPs) owning oil and gas pipelines in the United States, analysts routinely add back non-cash charges such as depreciation to net income to produce a truer picture of a company's earnings power and dividend-paying ability. Such an adjustment for Student Transportation would boost the company's earnings per share to more than $0.60 in 2011."

"Prescience Investment Group's 30-page report on Student Transportation is filled with figures and charts that claim to prove the company is dramatically overvalued and to present a scary picture of dividend stability. But the hedge fund managers behind the report clearly aren't independent analysts and have a vested interest in seeing the stock price decline. The timing of the report during Student's blackout period [when the company can't respond without facing SEC scrutiny] is also suspicious. And a closer examination of the report suggests that many of the report's bearish claims don't stand up to even the most cursory scrutiny."

Paul's conclusion: The drop in STB's share price as a result of the report offers an opportunity to buy a quality dividend stock at an attractive price.

Keep in mind that given the controversy surround the shares, Student Transportation is more volatile right now than most income stocks. And there is no guarantee the shares will rise from here.

But Paul's bullish outlook is not based simply on the fact that the share price has been knocked down by this report.

The environment for Student Transportation is actually improving. Remember, the company runs fleets of school buses for school districts in the United States and Canada.

This is an expensive and capital-intensive business because those districts must buy buses, hire drivers and plan routes. At the same time, many school districts are strapped for cash right now and face significant budget cuts as local governments try to cut spending and reduce their deficits. One simple way for a school district to cut costs is to outsource their bus system to Student Transportation.

There's plenty of room for additional expansion because the industry is highly fragmented and the majority of school districts in the U.S. and Canada still handle their own busing needs (only about 30% of the industry is privatized, and that's among thousands of companies).

Action to Take --> With all this in mind, Paul believes "Student Transportation remains a 'buy' under $7.00."

[P.S. -- While Student Transportation trades in the U.S., it is based in Ontario. Because of that, its high yield shouldn't be too surprising. In general, you'll find international companies simply pay higher yields than their U.S. counterparts.

Consider that when we ran the numbers a few months ago, 17 profitable companies in the U.S. yielded 12% or more... but there were over 200 such stocks abroad. For more information, Paul has put together a presentation outlining more about investing in high-yielding international companies -- including several names and ticker symbols. You can watch the presentation here. Or, if you prefer to see the text version, visit this link.]

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